Ask Matt: When is the market expensive or cheap?

A: Investors love the idea of a stock market warning signal: A financial measure that will sound a loud alarm when the market is cheap or pricey.

Perhaps the closest number that approximates this kind of indicator is the price-to-earnings ratio. While investors routinely look at the P-E ratio of individual stocks, many aren’t aware the broad market has a P-E ratio too. The P-E ratio on the Standard & Poor’s 500 tells investors how much the market is paying for a claim to a $1 in earnings by the companies in the index.

Just as with P-E ratios on individual stocks, the P-E on the market can be a helpful guide to how pricey the market is getting. The P-E on the S&P 500 has ranged from a low of 11.5 to a high of 18.7 since 1988, says S&P Dow Jones Indices based on trailing operating earnings.

Sometimes when the P-E pushes the upward bound of the range, the market runs into trouble. For instance, the market’s P-E hit 17.8 in late 2007, just as the stock market was running into some major trouble. The S&P 500 is currently trading awfully close, at 17.2.

It’s not a perfect indicator. The P-E of the market was high in early 2009 with a P-E of more than 18, because earnings were so depressed. But investors who avoided the market, thinking it was too expensive, missed out on the mega market rally that has raged since 2009. While the P-E shows if investors are paying more or less for stocks, that’s not necessarily a tip off on the direction of the market.

USA TODAY markets reporter Matt Krantz answers a different reader question every weekday. To submit a question, e-mail Matt at mkrantz@usatoday.com or on Twitter @mattkrantz